Economics

Europe's debt crisis

Trichet's long game

DESPITE being almost alone in its hard-line opposition to any form of Greek debt restructuring, the European Central Bank looks set to win the current round of Greek bail-out negotiations. As my colleagues have noted, an informal and voluntary debt rollover won't deal with Greece's underlying insolvency, and may make a future restructuring more complicated. This can-kicking exercise will end in tears.

Delay does, however, affect the likely political consequences of a debt restructuring. Research from JPMorgan, highlighted by FT Alphaville over the weekend, shows how euro-zone states are increasingly responsible for Greek debt (directly or indirectly through the ECB) as private creditors' bonds mature and the bail-out tab rises. Future debt restructuring will be more costly for European states and fiscal integration more attractive.

This amounts to the advance of European integration by the back door, a time-honoured EU tradition. Judging by his provocative remarks at the Charlemagne prize ceremony—an award previously given to the euro itself—that may well be Jean-Claude Trichet's goal in seeking to defer a debt restructuring. And the ECB, like any human institution, responds to the political perspective and personal ambitions of its leadership.

There are, of course, alternative rationales for the ECB's obdurate approach—self-preservation; fear of a "Lehman moment"—but I find it hard to imagine that the political consequences are lost on the ECB's president. Mr Trichet, once an advisor to arch-EU federalist French President Giscard d'Estaing, has shown no compunction about wading into the political debate over the future governance of Europe, despite the ECB's notionally apolitical role and lack of democratic mandate.

If so, it's a game of brinkmanship that comes with great risk for the ECB. Its leaders' strident statements—even slapping down Vice President Vitor Constâncio by “replacing” his ambiguous remarks on maturity extensions with a categorical rejection—leave no room for compromise, and the ECB hasn't dropped any hints that this is just a tough negotiating tactic. The ECB has put its credibility on the line; now any near-term restructuring will create the perception that the euro's independent monetary authority has bent to the will of sovereign euro-states.

Moreover, the ECB's bond purchases and collateral exposure have left it dangerously exposed to a haircut. According to Open Europe, a London-based think tank, the ECB faces up to €444 billion in potential losses from struggling euro-zone countries and €140 billion from Greece alone—itself a factor putting pressure on European states to delay debt restructuring, as the ECB's losses would force a recapitalisation of the central bank.

Thus far, Mr Trichet has held his nerve in this high-stakes stand-off, and the ECB's position may be reinforced by the appointment of Christine Lagarde as IMF chief; Ms Lagarde is reputedly "the most uncompromising opponent of a Greek debt restructuring among euro zone ministers". Despite opposition from voters, the path of least resistance for EU politicians remains to put off debt restructuring for a bit longer, and the euro zone could well muddle into a fiscal union.

Still, Mr Trichet's gamble could backfire in the coming months—if, say, Greek citizens revolt against austerity and force a haircut on bondholders or European political leaders give in to public pressure. In that case, the ECB's brinksmanship will have had disastrous consequences for itself and for Europe.

I've been convinced since Trichet started talking about tightening that he was playing a game of chicken. He is certainly trying to force the fiscal integration that he has spoken out for. It really is the only reasonable course of action if everyone now in the Euro is to stay in.

@sauerkraut your opinion is a voice of reason. The only problem is the leaders of EU are anything but reasonable. They look at the world through the prism of ideology and this ideology is socialism.

A primer in socialist economy: The prime objective of a company in a socialist economy is not to make a profit but to fulfill a correct social function. The party leadership decides what this correct social function is at any given point of time.

I think the EU leaders knew very well that the Greeks did not deserve the AAA credit rating that allowed them to borrow money at the same interests rate as the Germans but decided not do anything because it suited their political purposes. EU leaders are not and have never have been accountable to the inhabitants of EU and this just the beginning of their (and EU itself) shortcomings.

Leaders make mistakes, this is human. But if they follow a suicidal ideology and there is no simple mechanism to correct their decision or replace them it is lethal. Expect another revolution.

Further to my comment on Greece :
I wonder whether Trichet and a number of other high placed euro artists really understand money. Shoveling euro's from one place to another does not bring a dead economy back to life as we can see in the US where banks and industry are loaded with trillions and cannot usefully invest, thereby leaving the unemployed as they are.Earnings are up : like foam on a glass of beer,looks nice but has little value.
Money is like a permit from the government :it allows you to trade and deal in 'controlled' manner. A million building permits however don't make any buildings unless someone needs one.
Secondly,allowing Greece to live it up for years also does not impress me with regard to the financial capabilities of the eurotic bankers.

The key phrase in the post is "...if, say, Greek citizens revolt against austerity". In it, "say" just shows what a polite English gentleman the writer of the post is.

Greek citizens certainly won't go along with any austerity measures; more over, they won't start gaining dough in the sweat of their faces - historically, they did it only when some General Metaxas or a bunch of colonels forced them.

So whatever Trichet or anybody else in the EU is pushing for, the only possible outcome would be unadulterated bankruptcy of the country. And the sooner the better.

The institutions that lend money to Greece did it on their own free will, werent obviously fully aware of the risks but "I didnt know" is not a good enough excuse when your investment goes bad. They should accept the loss of part of their investment since as everybody knows Greece is insolvent.

Forcing a depression on the Greek population is unacceptable I think from its European partners despite how many rules they broke. Throwing European tax payers money on the problem is equally unacceptable as it will not solve the problem and creates moral hazard.

AS for the increasing number of comments that suggest that the Greeks are lazy, I have to say "rubbish", the civil servants are lazy but you would be too if there is no sign of meritocracy and you can never be fired. This is why communism failed miserably everywhere it was tried.

The problem is not one of laziness, but one of proper education and broken government. Despite economics being a Greek word it seems to me that most of the Greek press and people have no idea how modern economies work.

Being Greek myself I have to say I have lost all hope for my country's future and that now is a time for fellow Europeans to help my country and not push it further into the abyss. A good way of helping would be to demand that European technocrats be enstated in key positions in the Greek government to do what is sorely needed but politically suicidal for any Greek government.

Also to my fellow Greeks. I hope this is a good time to stop voting for the governing a****oles, the traitorous main opposition party and the idiotic left. Who's left to vote, I dont know, but we can think of something

Greece cannot earn enough money to be part of the euro zone and must therefore use its own currency.In that mode they will enjoy an economy they can afford.
Extreme fiscal restraint is not a solution, because it prevents a poor man to be "poor" in an acceptable manner.
And, of course ,trade restrictions come with it as well as a military junta.

Politics in Europe must be local to be responsive. Europe should stay flexible, not melded rigidly into one country. With more than 12 languages, it'd be difficult to get local conditions addressed responsively through an EU congress. Local parliaments allow citizens to give input where it's needed most. At the same time, with flexibility responsibility for foolishness in the south of the continent can also be local.

Let the Greeks return to their own currency without destroying other countries far away whose populations and leadership took the bitter pill and acted responsibly.

Forcing the euro as the only national currency for new members was a bear trap set with 'economic prosperity' as the lure. It was a power-grab by self-serving politicians who want other people to pull their chestnuts out of the fire. They want someone else to pay for the unfunded, unaffordable entitlements that they enacted to increase their reelection chances.

In the end, centralized bureaucrats will ineffectively respond to crises that they don't understand. Few people speak more than 12 languages and will have close connections with the locals. We're talking about 500 million people. Bureaucrats will impose chaffing rules that will be ineffective and may even damage people's lives. Even the best bureaucracy takes too long when there are so many stakeholders: Even the fast-track of the European Medicines Agency requires twice the time to approve a medicine as the U.S. FDA takes.

When monetary policy is decided on the level of the European congress, politics will become an inadequate feedback mechanism. Out of frustration, the 31 nations and their leaders will choose a smooth-talking, problem-solving politician to be an emperor, as Napoleon and Hitler were. Hitler and Napoleon were persuasive and charismatic until they had absolute power; then they were a nightmare.

In summary, economic flexibility suggests that local currencies be used in tandem with the euro as it is in Great Britain. If local politicians enact disastrous policies, then their foolishness won't sink the economic ship of the entire continent. Each political group can work their way out of their spending problem more quickly by using economic discipline and floating their currency, letting the market sort things out.

The most ominous and the shrewdest comment by P.B. comes in the penultimate paragraph: “Despite opposition from voters, the path of least resistance for EU politicians remains to put off debt restructuring for a bit longer, and the EU zone could well muddle into a fiscal union”. This implicitly recognises both the unstoppable ratchet mechanism that drives the EU and, perhaps even more worryingly, the easy acceptance of the EU’s antidemocratic nature. It is taken for granted by the writer that “opposition from voters” will be brushed aside by unelected apparatchiks and that the federalist drive will continue unabated.
And the casual abandonment of any distinction between Europe and the EU (see the essay’s final sentence) should make all true democrats shiver.

First of all I really like the comments I could read so far.Especially from those ,who could care less,because they do not live in the Eurozone.We here in Germany are a little bit nervous,because as it looks,there will be efforts to let Germany pay for the greek financial,self inflicted desaster,alone. We are being accused already,that it is our fault and obligation,because the innocent greek population bought german products.And now we must bail them out.Good argument! We Germans should donate our products and not have the audacity to want them being paid for. The real stinking problem is that the greek oligarchia in politics,the financial sector,and in other leading circles instrumented the entrance into the European Union,to have the good life for many years to come.They knew what they were doing,when they delivered fake statistics to the Euro-staistics unit in Brussels.
But our officials in the EU,in Brussels are to be blamed,for not having looked into the matter early in time.It's like Maddoff.The same scheme.I had the impression,letting Greece join the Eurozone was maybe decided by some old EU-politicians,who had greek,old greek in school,plus that eternal blah blah about Greece being the cradle of democracy,plus kicking the Turks,or why would Germany take in orders for submarines to be built and delivered to the greek navy? We should allow the Turks to join,under one condition:no agricultural subsidies,like they were forked out all those decades before,which led to Mafia-style misuse,and has cost the European taxpayer more than this bail-out for Greece now.
Folks out there,please comment on my arguments.Thank You!

Mr. Trichet will retire soon from the EZB. He has no longer to live with his decisions. Mrs. Lagarde in her new function als chairwomen of the IMF will certainly support the PIGS and all the other european countries living beyond their means.

Forgive my ignorance, but even if Greece did resurrect the drachma or started a secondary European currency (demiEuro) and exited the Euro..... quite possibly I know... won't its debt STILL be denominated in Euros?

So while a reintroduced drachma or introduced demiEuro will allow Greece to depreciate and hence make its economy more competitive, won't it then inflate its non-drachma/demiEuro (read Euro) debt further and hence make repayments even more difficult.

I'm all for a demiEuro - one size does not fit all EU countries. Two currencies over 500 million people will allow blocks of countries to have differing economic policies and directions but still create integration and scales of economy.

It will also create a mechanism for countries to potentially move from one block to another depending on their future conditions - or even allow the demiEuro to be used by more non-EU countries.

"They knew what they were doing,when they delivered fake statistics to the Euro-staistics unit in Brussels. [...] ...eternal blah blah about Greece being the cradle of democracy"

That is one hundred per cent right. Those in the EU who continue to treat Greece as a trustworthy and respectable partner who inadvertently got in trouble and thus deserves to be helped out, should wake up to the reality: Greece is a cradle not of democracy and culture, but of institutional corruption. And the institutional corruption there is a consequence of crookedness as the main mental characteristic of the populace strengthened by the epidemic Leftism.

To Cloud-warrior: Changing Greece’s currency back to a dual Drachma-Euro system won’t cause their debt to disappear, but the European governments loaning them money will know that Greece's politicians can't again hold them hostage. Future debt would be in Drachmas. The market would determine the value of the Drachma compared to the Euro as it does the British Pound.

If Greek politicians continue to pass entitlements that the average taxpayer can't afford, the value of Drachma and the Greek worker's wages would be cut by inflation. However, the larger economic system would remain intact, giving them a chance at recovery. That's better than the Greek government repudiating its debt, causing a hyperinflation that would destroy Greece and might hurt other nations.

Government repudiation of debt usually causes a hyperinflation of its currency. When the currency becomes worthless, the middle class loses its savings and retirement investments, and businesses and banks fail because their cash-reserves are worthless. These bankruptcies would cause widespread economic hardship in Greece as it did in Germany in 1923. Adam Smith wrote in his book "Paper Money", that Walter Levy's father’s entire 20-year annuity policy went to pay for "a single loaf of bread." http://www.pbs.org/wgbh/commandingheights/shared/minitext/ess_germanhype...

With a dual currency, local politicians in member nation couldn't destroy the euro or the Eurozone economic system. Preserving the individual member nation's currency is a necessity unless Europeans want taxes and fiscal policy imposed from a huge central government that does not understand what is going on in each individual country, or what the citizens in that country are going through.

Why did the threat of default occur? The Greek Socialist party may have thought they could run up a tax bill that their voters wouldn't have to pay. Instead, the wealthier European nations could pay it. However, the citizens of the 30 other nations in the EU may dislike having their taxes raised because of bone-headed local politicians in a foreign land.

They must now bail Greece out because default might destroy the value of the Euro, causing all nations that have the Euro as their only currency like to also experience hyperinflation and depression. Alternately, if the Greek people won't tighten their belt, the EU member nations could expel Greece from the EU and repudiate all debt arising from Greece.

In that case the Greek government would have to go back to the Drachma anyway. The people of Greece would experience hyperinflation and their economic ties with the rest of Europe that had brought them prosperity would no longer exist.

Here's are the options for Greece:
1) Put up with a loss of government jobs and services for several years, as Brazil did, and recover.
or
2) Do not accept the cutbacks and suffer a severe hyperinflation caused by the Greek Government repudiating its debts.

If they don’t take the ‘medicine’ for their politicians' mistakes, Greece would receive no help from the EU. In addition, it would be expelled from the EU and Greek debt repudiated. There could be no jobs and a severe and unending economic depression would ensue: most businesses and banks would go bankrupt causing the economy to slide into an inescapable pit because the hyperinflation would cause their cash reserve to be worthless; There would be no personal or government-based retirement. Government services would be cut to an absolute minimum. To see what happened to Bolivia under similar circumstances, click on the link below.(9 min) http://www.youtube.com/watch?v=ScXCBJkp3s4

Sometimes pragmatic understanding triumphs over foolish actions. In 1985, by the plan of Gonzalo "Goni" Sanchez de Losada, the elected Bolivian party stopped Bolivia’s hyperinflation by cutting services to the level of incoming revenue. Bolivia’s success inspired Brazil to do the same. In 1995, after 40 years of inflation, Brazil's Socialist economic minister, Fernando Henrique Cardoso, cut services to the number of Reals collected in taxes. http://crab.rutgers.edu/~goertzel/fhc.htm.
By the time Cardozo left office in 2003, Brazil had become one of the most vital economies in the world.

Like Brazil Greece could spend the next 40 years in a hellish limbo of hyperinflation; or they could skip hyperinflation by taking their medicine: accept the painful government service cutbacks with the promise of eventual economic recovery.